If owning a home is part of the American Dream then I guess mortgages would be one way to go about financing the American Dream. The very thing that makes home ownership possible for the vast majority in America is the same thing that everyone is so quick to want to get rid of. Can the home mortgage be that bad? Perhaps it’s the long list of financial gurus on air and in books that have pointed out how if you keep your 30 year mortgage, you could end up paying 2 to 3 times the cost of the house when you factor in the interest payments made to the financial institution. And you know what, they’re right. But the fact is – that’s not the whole story.
My hope is that your goal will be not only to get a mortgage, but to keep a mortgage on your home for as long as you live and to teach your kids to keep one on their home for as long as they live as well. To be clear, I am the biggest proponent of being debt free and having your home paid off. The only difference between the masses and my way of thinking is the way that I define being debt-free and having your home paid off.
For me, being debt free means not having any debt besides your mortgage and having all the money in a safe, liquid and accessible account such that IF for some reason you thought it was prudent to not keep your mortgage, then you could pay it off with the stroke of a pen by writing a check.
Now, let’s first have a healthy discussion about mortgages – you know, that thing that the financial gurus would have you to believe is a necessary evil to home ownership. To start off the discussion, we’ll begin with a quick quiz on mortgages. It’s true or false so you’ve got at least a 50/50 chance on each question.
Mortgage Quiz – True or False
- A large down payment will save you more money over time than a small down payment
- A 15-year mortgage will save more money over time than a 30-year mortgage
- Making extra principal payments saves you money
- The interest rate is the main factor in determining the cost of a mortgage
- You are more secure having your house paid off than financed 100%
If you answered True to all 5 questions, then I’d say the financial guru’s have done a pretty good job of “brain-washing” you with their brand of wisdom. The correct answer to all of these questions is False and why they are false will be apparent in some future articles. But for now, let’s look at a few of the different types of mortgages and continue with the discussion of why have a mortgage at all.
If you met with a mortgage broker or financial institution, you would be presented with a dizzying array of mortgage options. They could offer you a traditional 30-year mortgage, a 15- year mortgage, an interest only mortgage, an adjustable rate mortgage, or mortgages with balloon payments just to name a few. With so many options to choose from, how do you know what’s the right choice? Let me ask you this question: If the financial institution made the same amount of money on each mortgage option, how many choices would they offer you? Yup – you got it…just one. So, obviously there are some mortgage options that are more profitable to the financial institution than others. On the same token, you’d have to agree that there are some mortgage options that are more advantageous to you the consumer. Wouldn’t it help to know which one was better for you? But first, why get a mortgage at all?
While we could spend an entire day discussing why you should not have a mortgage, there are only 4 reasons I know why I would advise you to get one. Those 4 reasons are:
- You don’t have the cash to buy your home. You’re getting ready to turn 30 years old and your mom says it’s time to get out of the house…and you don’t have the cash to pay for a home.
- The tax deductions. Under current law, the interest on loans acquired to purchase a home that does not exceed $1,000,000 is deductible on schedule A of your tax return. The tax deductions are a great incentive to get a mortgage and probably a good reason to always have one.
- The Leverage advantage. To enhance your potential return on investment from the sale of your residence, a mortgage would allow you to put a little money down (up to 20%) and command an asset that is worth 5 times or more than what you put down. If your home appreciates in value and you sell at a profit, your return would be magnified 5 times if you put 20% down.
- The spread. The spread refers to the arbitrage profit potential that exists between the costs of borrowing money versus what you can earn on your own money. Taking advantage of arbitrage profit opportunities is one of the ways banks make a lot of money.
Understanding the reasons to have a mortgage, which type to have and how to manage it is a crucial component of your financial plan. Getting a mortgage and keeping one on your home can have very positive effects to your long term financial goals. Helping clients understand how the four reasons to get a mortgage play an integral part to accumulating wealth is what we do. It’s just another way we help our clients with winning the money game and achieving financial independence.